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Q: Capital Gain Tax with a Gift of Equity ( No Answer,   1 Comment )
Subject: Capital Gain Tax with a Gift of Equity
Category: Business and Money > Accounting
Asked by: dmbenmcc-ga
List Price: $25.00
Posted: 24 Jul 2006 18:57 PDT
Expires: 23 Aug 2006 18:57 PDT
Question ID: 749189
We are purchasing a home from my wife's parents (in Colorado) and they
are giving us a bit of a break on the sale price. Here is the

Appraised value: 295k
Purchase Price: 245k

By using a cash down payment and the gift of equity (295k-245k) we are
able to put down 20% on the property and therefore obtain a better

We understand the difference between the purchase price and the FMV
(50k) must be handled as a gift of equity and is subject to gift tax.
However, it appears the gift tax can be avoided by following the
guidelines listed here:,,id=98968,00.htmlestate

Using 48k from annual exclusions (12k x 4 people involved), the
remaining 2k can be deducted from their lifetime unified tax credit.

My wifes parents use the property as rental and  are not going to buy
another property, so they must pay taxes on their capital gain. It
seems the taxable amount is: purchase price - basis. Assuming this is
correct and their basis is 150k, they would be paying taxes on 95k
(245k-150k), which would be $14,250 (at 15%). On the other hand, they
would have to pay taxes on the FMV-basis (295k-150k)

In summary we have the following questions for you:
1) Can the gift come from the seller since they are closely related
and are the deductions correct? If not, what is the situation? Please
provide links to the IRS or other tax website as a reference for us.

2) What amount must they pay capital gains on? PP-basis or FMV-basis
(This is the primary question)? If they must pay capital gains on the
FMV, can we pay them the difference in taxes directly (approximately
7k) with no tax consequences? Again, please provide references.

We can not move forward with this transaction until we receive this
information, so please respond as soon as possible.

There is no answer at this time.

Subject: Re: Capital Gain Tax with a Gift of Equity
From: abezon-ga on 24 Jul 2006 20:26 PDT
1. The seller can make a gift of equity. It's called a "bargain sale"
in tax-speak. Pub. 544 mentions it briefly & notes that losses on
bargain sales are disallowed. Gain is based on the actual sale price
rather than FMV. IRS Regulation sec. 1.1001-1(e).

2. The parents will pay capital gains on the purchase price -
*adjusted* basis - costs of sale. Costs of sale include any attorney
fees, title insurance, repairs to ready the house for sale, excise
taxes, commissions, etc. The adjusted basis is the original basis plus
any increases (improvements they have or should have been
depreciating) minus any decreases (usually depreciation claimed or
that could have been claimed). If they have not been claiming
depreciation, they should consult a tax pro in their area about
claiming 'catch-up' depreciation before selling the house. This is
important because recapture of depreciation "allowed or allowable" is
taxed as ordinary income to a maximum rate of 25%. Capital gains are
taxed at 5 or 15% depending on their tax bracket. They will report the
sale on Form 4797 Parts I (land portion) & III (house portion).

Assuming they paid $150,000 for the house, they could reasonably have
expenses of sale of about $5,000, capital gains of about $90,000, &
'unrecaptured sec. 1250 gains' (depreciation) of $5,000 to $25,000.
That last was a wild guess that the house has been in service for 2-7
years, they depreciated it over 27.5 years, & about 1/3 of the price
was land.

3. The parents will file a joint Form 709 Gift tax return & elect gift
splitting. They sould be sure to keep copies of the 709 with their
wills, as their executors will need it eventually.

4. Do not set this up as an installment sale. Because you are related
parties, the parents would have to pay taxes on the entire gain in the
year of sale even though they get the money over multiple years.

I strongly suggest the parents hire someone to prepare their 2006
returns if they usually self-prepare. It'll cost $300, but will be
done right. If they go to a chain firm (H&R Block), they should make
sure they get an experienced preparer with many rental house sales
under his/her belt. They might also ask for an enrolled agent.

Good luck, 
T Meek
Enrolled Agent

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